Why the Lowest Mortgage Rate is Not Always the Best Rate For You

Many times I am contacted by mortgage clients asking about what my best mortgage rate is. It is common to believe that everything is an apples vs. apples comparison with regards to mortgage rates, and that the lowest rate is always the best deal. However, this is often not the case.

Borrowers often overlook the terms of the mortgage, or do not receive disclosure of items that are not attractive to an offer (particularly from Canadian banks). Below are some of the situations where taking the lowest rate will often cost you money in the long run:

-Many times the bank will not even approve you for the amount you need to buy the home you want. However, there are other “A” mortgage lenders out there who will approve you and also give excellent rates.

-I have also had clients who were with a bank who required that the money was taken from an account at their institution, which is not where they banked, and they found it very inconvenient to have to transfer money every month.

-Your mortgage lender may offer you a low rate to get into the door, and then when it comes time to renew your mortgage provide you an offer that is significantly higher than the market is offering. At that time it may be difficult for you to get an approval elsewhere and you could be stuck with their offer.

-If you get a variable mortgage with the intention to lock in to a fixed mortgage rate at a later date, many bank lenders will only give you posted rates when you lock in, meaning your interest rate will be much higher.

-Do you want mortgage life insurance coverage to protect yourself in case of death or disability? Many lenders including all the banks offer coverage that is strictly tied to their institution, so if you become sick during that coverage and try to move your mortgage, they will discontinue coverage and you will be paying much higher premiums to be re-insured elsewhere.

-Home Equity Line of Credit (HELOC) mortgages are often reported on the credit bureau, particularly with the banks and credit unions. It is generally much more favourable to have a HELOC mortgage that is not reporting on your credit bureau, as it is more favourable for your credit score. This could save you money and allow you to borrow money easier in the future.

-Sometimes a lender has a product that works with a strategy that is of benefit to you but may not offer the very lowest rate to get those benefits. An example of this would be the TDMP mortgages, which is a structure to make your mortgage tax deductible in Canada, and can help to create a great deal more wealth than a lower rate may offer.

Save Money on your Mortgage, Not Just on Your Mortgage Rate

These are just a few examples of things that could cost you much more money than saving.1% on your rate will give you. Keep this in mind next time you meet with your banker about your mortgage and often it is best to seek a second opinion from a mortgage broker who can give you helpful advice.

What You Need to Know About Mortgage Rates

Mortgage rates involve a number of factors and it is helpful to have a better understanding of how they work before choosing a mortgage.

Mortgage Rate vs. Annual Percentage Rate (APR)

To put it simply, the mortgage rate is the rate of interest charged on a mortgage. In other words, it is the cost involved in borrowing money for your loan. Think of it as the base cost. Mortgage rates differ from the annual percentage rate (APR). The mortgage rate describes the loan interest only, while APR includes any other costs or fees charged by the lender. The US Government requires mortgage lenders to provide their APR through the Truth in Lending Act. It allows consumers to have an apples to apples comparison of what a loan will cost them through different lenders. Keep in mind that lenders may calculate APR differently and APR also assumes you will hold the loan for its full amortization so it is still important to carefully compare and consider when selecting a loan.

How is the Mortgage Rate Determined?

First, the Federal Reserve determines a rate called the Federal Funds Rate. The Federal Reserve Bank requires that lenders maintain a percentage of deposits on hand each night. This is called the reserve requirement. Banks will borrow from each other to meet their reserve requirements. When the Federal Funds Rate is high, banks are able to borrow less money and the money they do lend is at a higher rate. When low, banks are more likely to borrow from each other to maintain their reserve requirement. It allows them to borrow more money and the interest rate goes down as well. The interest rates fluctuate with the Federal Funds Rate because it affects the amount of money that can be borrowed. Because money is scarcer, it is more expensive.

Also, when the Fed decreases their rates, we tend to spend more. Because loans are more inexpensive, people are more likely to use them to invest in capital. Also, because interest rates are low, savings accounts are reduced because they are not as valuable. This creates a surplus of money in the marketplace which lowers the value of the dollar and eventually becomes inflation. With inflation, mortgage rates increase so the Fed must carefully monitor their rate to ensure that our economy remains level.

Basically, the Federal Funds Rate is a large determinant of what the mortgage rate will be on a given day. And the Federal Funds Rate is largely determined based on the market including factors such as unemployment, growth, and inflation. However, there is no single mortgage rate at a given moment that every borrower will pay. This is because there are also other factors which determine an individual’s mortgage rate, and why they different people will have different rates.

Individual Determinants

There are several things that a lender can examine when determining your mortgage rate. One key factor is your credit score. A higher credit score makes you less risky to lend to and can significantly improve the rate you have to pay. You can also purchase “points” which are pre-payments on your loan interest. Speak with your lender to discuss points and how they might affect your loan. Finally, the amount of down payment can also change the interest rate. Typically, if you have more money up front, you have to borrow less, and you reduce the risk for the lender and your cost for the loan.

Mortgage rates are generally changing daily. Some lenders will stabilize their rates more than others, but it is always wise to compare rates between lenders at the same time and on the same mortgage type. It is also important to know that when a lender provides you with a rate, it is not a guarantee that tomorrow, the rate will still apply. Until you have chosen a mortgage and lock your rate in place with the lender, fluctuations can occur. As with any financial decision it is important to do your research and understand what you are getting into. It’s always wise to consult with your lender for personalized advice.

The Shopping for a Mortgage Rate Game

I have been advising borrowers who need residential mortgage financing for over seventeen years. My experience shows that no matter how sharp, intelligent, smart, educated, or ignorant a borrower is — the mortgage rate trap that they all fall into is the same. Unfortunately, by the time a borrower realizes that they have been misinformed, mislead, or just been given only part of the mortgage rate story; their inept, inexperienced, unknowledgeable, and eventually disinterested loan officer/customer service rep has earned an undeserved commission.

How many times do I sit and answer my phone only to hear “Hi, I was referred to you by so and so, and uh, I’d just like to know, uh, what is your rate is today?” My mind races with “Are you in contract? How much are you looking to borrow? What is the size of your current mortgage? What is the purchase price? How is your credit? Can you verify income? Are you locking the rate? How long are you looking to lock the rate for? When are you looking to close? Do you own any other properties? Are you buying the property to live in or for an investment? What type of property are you buying?” You see, the answer to all theses pertinent questions (and more) EFFECTS THE RATE! This warrants repeating one more time — the answer to all theses pertinent questions (and more) EFFECTS THE RATE! So, I say to the respective caller while qualifying my answer, “If you have good credit, can verify your income, intend to live in the property, and can show enough liquid assets to buy the property than the prevailing mortgage rate is X.”

Please understand, I do not blame borrowers for asking the question, BUT, I, as a mortgage professional, get frustrated seeing consumers, make the biggest financial decision of their life based on misleading advertisements and other information or lack thereof. The kicker is, that many mortgage companies’ advertisements and customer representatives confuse and/or mislead the consumer into applying for a mortgage with their company while legally and ironically complying with the federal laws set up by our government to protect the consumer. When do you or the borrower find out that the rate and closing costs are not what they appeared to be — AT THE CLOSING! The old bait and switch is still around, but even more costly is the withholding of relative information. Many mortgage officers feel they have a greater chance of closing your mortgage when they give you a direct answer to your direct question without volunteering the other pertinent information you would want to know, if you knew enough about mortgages to ask. This other information used in conjunction with the “what is your rate?” question can save you big bucks at the closing table and over the life of your loan.

There are many variables that go into each and every mortgage deal, and every deal is unique unto the borrower. I will try to provide you with some a general guideline of the “other information” you need to be aware of, so that you will be able to shop for mortgage rates intelligently, and, if you so desire, select a mortgage professional who knows what they are doing which may, consequently save you thousands of dollars.

1.Rates fluctuate daily. Some lenders lag behind the market, and some lenders adjust immediately to the market.

2. A conforming mortgage conforms to Fannie Mae and Freddie Macs; (the biggest purchasers of mortgages) underwriting guidelines. Their 2007 loan ceilings are: 1 family homes $417,000 2 family homes $533,850 3 family homes $645,300 and 4 family homes $801,950. The rates are generally competitive among lenders give or take an eighth to a quarter of a rate. “Jumbo” mortgages exceed the conforming ceilings. Jumbo rates are usually higher than conforming rates.

3. Occupancy affects rates. A primary residence is occupied by the borrower. A rate may have an add- on (increase), if the property is a second home, vacation home, or if the property is used for investment (you rent it out).

4. Loan to value (LTV) is the mortgage amount divided by the value of the property. The higher the LTV, the greater the risk to the lender, and the possibility of a higher rate.

5. A cash out refinance (cash over and above your existing mortgage) may incur an increase in rate depending on the lender.

6. Generally, the shorter the loan term (30 year vs. 15 year), the lower the rate.

7. The better the credit the better the rate. Today lenders are really focused on a credit score. A number determined by comparing your credit pattern and history to the credit bureaus database of proprietary mathematical formulas and models of historical consumer credit patterns. If your score is low, you might be a candidate for re-scoring your credit (legally) to bring up your score and consequently give you an opportunity for a better rate. Make sure that your time frame for getting the money you need coincides with the time it takes to correct or repair your credit. Otherwise, the time it takes to correct or repair your report may prevent you from taking advantage of current low rates or special deals which defeats the whole purpose (“A bird in the hand…”.)

8. Compensating factors affect the rate. The lender may offer you a lower rate because of a low LTV. A great credit score with borderline income may allow you to squeeze into a better mortgage rate.

9. Mortgage Brokers and Lenders have different programs for different types of borrowers. Generally, the more financial information you supply the better the rate. The programs are: Full income Full asset verification, No income with asset verification, No income No asset verification, and Stated income with asset verification. The key is to make sure that you match yourself to the right program so you not only get the appropriate rate, but to also make sure you don’t get turned down. For example, you apply for a full income full asset loan program, but you do not show the income needed to qualify on your tax return, but you may have qualified on a No income verification type of program.

10.There is, or supposed to be, a correlation between rates and points. A point is an up front fee of 1% of the loan amount you are borrowing. “Buying down the rate” means paying points to lower your rate. “Buying up the rate” means, paying fewer points to increase the rate. You would most likely want to pay points if: (a) you need to lower the rate to qualify (b) you will own the property long enough to amortize (recapture) the point money you paid up front (c) You have the extra cash. You will most likely not want to pay points if: (a) You don’t have the extra money (b) You will own the property for a very short time (c) You think rates are going to decline shortly. There are other reasons for paying and not paying points, which should be discussed on a case-by-case basis.

I have saved the best for last!

11. LOCKING THE RATE. When you call and ask “what is your rate?” you will generally get quoted the prevailing rate, a/k/a as the floating rate, which means, if you are ready and able to close within 15-21 days (which means you have applied for a mortgage, supplied your financial information, have a commitment from the lender, an appraisal, a title report, etc.), and you locked in the rate right now, this is the rate you would get. Now, how many first time homebuyers do you think fit that situation, Hmmm? Most residential purchase real estate transactions do not realistically fit a prevailing rate time frame. Most borrowers are not informed, at the time they are quoted the rate, about the if you are ready to close in 15-21 days closing time frame. Therefore, if rates are dropping, fine. BUT, if rates are increasing — Surprise!

Prevailing rate quotes will always be lower than locked in rate quotes. So, if you are rate shopping and want to compare apples to apples, when you are quoted a rate, the key thing is to make sure you ask: “How long the rate is locked in (protected) for? Are there any points, origination fees, broker fees? What lock-in time frames are available?” More importantly, make sure you can close within that time frame otherwise you may be subject to extension fees. Generally, the longer the lock the more it costs. Lock in periods are usually 15 days, 30 days, 45 days, 90 days, 120 days, 180 days. Paying points, increasing the rate, or both, incorporates the cost of the lock. You may want to ask if a float down option is available (if the rate drops after you lock can you get the lower rate.) More importantly than getting a rate lock agreement in writing, make sure the person you’re dealing with is honest, reputable, and whose word means something.

12. The APR (Annual percentage rate). I call it Another Proven Rip-off. A borrower is supposed to be given the APR along with the closing costs and rate information. If you look in the newspaper adds you will often see a rate advertised about one half to one percent lower than the real market rate. If you look on the side of that rate you will see what is known as the APR. This advertisement is perfectly legal, as long as the rate stated is accompanied by the APR rate, but in reality this is very tricky. According to the federal regulation Z, the APR is supposed to be the measure of the true cost of credit, expressed as a yearly rate. The government is trying to assist you, the consumer, in your loan decisions by making loan providers give you the APR “true cost of credit.” They mean well, but, unfortunately, most people do not have the sophistication, knowledge, time or financial calculator needed to figure out the APR. Long story short, by taking the loan amount, the rate you are quoted, and factoring closing costs into the calculation you arrive at the APR. So the rate you see in the newspaper that appears to be lower than everyone else means nothing unless you know exactly what the closing costs are. In these cases, the APR conceals the closing costs. You will find out that most of these advertised below market rates have several points built in to the closing costs. When mortgage shopping, instead of comparing APR’s, for your sake keeps it simple. Find out the rate, how long it’s locked in for, and all closing costs included and then compare. I hope this article helps you save thousands of dollars and good luck to all mortgage shoppers.